Before purchasing a property in an SMSF, make sure you do all the necessary checks, particularly where borrowing is involved.
1. Is it the right investment for the superannuation fund?
The investment strategy of the SMSF needs to be considered in regards to the range of investments available to the trustee. If it is noted that the purchase of a property will cause the range of investments permitted under the investment strategy to be out of alignment, the trustee should consider amending the investment strategy.
2. Does the fund have the resources to purchase the property outright?
Initial questions the trustee needs to answer are:
- Will the SMSF purchase the property using available resources of the SMSF;
- Is it prepared to commit a significant portion of the SMSF assets towards the purchase of a ‘lumpy’
asset at the expense of diversification; and
- Will it be more prudent to purchase a property of a value greater than the available resources, using borrowed funds to complete the purchase.
3. Should the property be purchased in the SMSF or in another entity?
Once the decision has been made regarding the property to be purchased, the next consideration is the proper structure in which the property will be owned. Will the trustee of the SMSF own the property or will, for example, the SMSF own units in a unit trust that will, in turn, own the property?
Unit trusts can provide a number of advantages in comparison to holding the property in the SMSF. They include:
- Providing protection for other assets of the SMSF in the event of accidental injury at the property; or
- Enabling activities that would not be permitted if the property was being purchased by the SMSF/bare trustee under am SMSF borrowing arrangement, e.g. significant improvements or development of the property.
4. Will the trustee borrow to acquire the property?
Having decided on the purchase and the structure, it is likely that the decision as to whether the fund will enter into an SMSF limited recourse borrowing arrangement (LRBA) will also have been made. The next decision could be whether the borrowing will be from a bank or other financial institution, or from a related party. Further to that, the amount that would be available for purchase under the borrowing would need to be ascertained.
5. How will the property be managed following the death of a member?
Once the SMSF has purchased an asset, such as property, which forms a significant (‘lumpy’) portion of the assets of the SMSF, consideration needs to be given to what would happen in the event of the death of a member. For example, it may be necessary for the property to be sold or transferred to beneficiaries, if the entitlements of those beneficiaries were required to be paid out of the SMSF. That would most likely occur when adult children or more remote dependents are the beneficiaries.
If the surviving spouse is to be the recipient of the death benefits, then the funds, including the ‘lumpy’ assets, could remain in the SMSF and provide a pension to the surviving spouse. That is predicated on the assumption that sufficient income will be generated from the property and other assets to meet the minimum pension requirements, or the higher cost of living requirements, of the spouse.
When the SMSF has borrowing obligations to meet, the situation is compounded.
Some subordinate considerations, if entering into an SMSF borrowing arrangement, include:
- Will the fund have sufficient liquidity to meet ongoing loan payments?
- Does the property to be purchased comprise multiple titles?
- Is there a plan to develop or significantly improve the property?
- Does the contract to purchase include the purchase of ancillary items, e.g. furniture in an apartment or machinery in a factory?
- Will the appropriate documentation be available prior to signing the contract?
- Who will sign the contract as purchaser?
- Who is the vendor?
- Who will occupy the property after settlement?
In the event of the disability of a member, particularly when the expected contributions in respect of that member are committed to meeting loan repayments, the fund can incur significant financial difficulties. Planning for that should take place at the time of purchase.
Generally, purchases under the SMSF borrowing arrangements must be under a single title to meet the single acquirable asset provisions. Exceptions to that rule include apartments and car parks that cannot be separated, and farms and factories that have major buildings across multiple titles.
Development or improvement
If the proposal is to develop or significantly improve the property, a standard SMSF LRBA is unlikely to suit. Purchase through a unit trust, most likely using related-party lending, may overcome the restriction.
The single acquirable asset provisions would be breached if the borrowing is used to purchase ancillary assets, such as furniture in an apartment, machinery in a factory or equipment on a farm. Those items should be purchased using SMSF funds, rather than borrowed funds.
Documentation and signing the contract
The trustee of the SMSF should not sign the contract. Preferably, the bare trust documentation should be available prior to entering into the contract, so as to avoid any subsequent repercussions. Rules as to the timing of signing both the bare trust documents and the contract of sale vary across each state or territory.
In NSW, Victoria, Tasmania, the ACT, South Australia and Queensland, the purchaser should be the name of the holding trustee only. There should not be any references to “as trustee for the bare trust” or “as trustee for the SMSF”. If you get this wrong, it may result in adverse stamp duty implications.
A corporate holding trustee is the smartest way to go, and this is usually the first step in any LRBA irrespective of where the property is located. Set up a company that can act as the holding trustee. Why is a company better? Companies don’t die, they don’t lose capacity and they don’t get divorced, so it is easier to change the directors rather than the names of individuals on a property title. Also, many lenders won’t lend unless the holding trustee is a company.
Some members want to use their own name as the purchaser and note ‘and/or nominee’, that is, “Jack and Jill Mogul and/or nominee”. In some states, such as NSW, this could result in ad valorem duty being charged when Jack and Jill nominate the holding trustee as the alternative purchaser, as this can be seen as a ‘sub-sale’. Currently Victoria is the only state where ‘and/or nominee’ can be used, but you should check the rules with a local conveyancer.
The name of the purchaser on the contract for NT property is very specific. It needs to be “Holding Trustee Pty Ltd ACN as trustee for Name of Holding Trust as bare trustee for Fund Trustee Pty Ltd ACN as trustee for Name of Fund ABN”.
In WA, the word ‘for’ must be used between the holding trustee and SMSF trustee names. It should be “Holding Trustee Pty Ltd ACN for Super Fund Trustee Pty Ltd ACN”.
If the vendor is a related party to the members of the SMSF, there are limitations on the assets that may be acquired. In particular, residential property could not be acquired from a related party in most instances.
Similarly, if the proposed tenant is a related party to members of the SMSF, the SIS legislation permits such an arrangement so long as the property is business real property and the lease is legally enforceable. If the property is residential property, it must not be leased to a related party.
Full Credit for this article to: Michael Harkin, national manager of training and advice, Topdocs